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BANKER’S VIEWPOINT

Bankers have sometimes maintained that they cannot create money because they can only ―lend out money entrusted to them by the public‖. What is to be said of this opinion?

The question takes us back to the basic distinction between commercial banks and other types of financial institutions. The liabilities of savings banks and savings and loan associations, for instance, like the time deposits of commercial banks, cannot be checked against. That is to say ―savings deposits are not usable as such in making payments, but must first be converted into currency or a demand deposit: that is why we have excluded them from our definition of money. And for the same reason institutions other than commercial banks are at a fatal disadvantage when it comes to creating money. For if a savings bank were to create a deposit by lending to a customer, it knows that the whole of the deposit will be immediately withdrawn: the savings bank will merely have transferred to the borrower either currency or a demand deposits will not be altered thereby: no money will have been created.

Contrast this operation with what happens when a commercial bank makes a loan to a customer. The bulk of the liabilities of commercial banks consist of demand deposit which can be used directly for making payments by writing checks. Therefore, when fresh demand deposits are created through the lending operations of commercial banks, such are not immediately withdrawn as currency but remain with the banking system. Admittedly any single bank may very well lose in the way of cash part or all of what it lends: the borrower wants to spend the money and ―checks it away. But when one commercial loses cash, it immediately reappears – for the most part – as a deposit in some other bank. The commercial banks collectively can create money, i.e. can create demand de-posits in favour of their customers, because such deposits can themselves be used for making payments without being converted into currency first. Indeed if demand deposits could not be used directly for making payments – through the writing of checks – they would resemble savings deposits, and we would not include them in our definition of ―money.

Of course two conditions must be met before a bank can create purchasing power in this fashion. (1) The bank must possess excess reserves over and above the customary or minimum legal reserves requirements currently in force. (2) The notes of creditworthy customers or other acceptable earnings assets must be available for the bank to acquire in exchange for the deposit it creates. But granted these two kinds of raw material are present – excess cash within the bank and acceptable assets for it acquire – the manufacture of bank deposits, i.e. money, can proceed merrily enough.

So the essential point is that when a bank makes a loan, much if not all of the proceeds of the loan will be checked away and redeposited in some other bank, whose lending power is thereby increased. Any one bank is subject to a flow of cash when it creates deposits, whereas the banking system as a whole is not subject to such a flow. Therefore, although any single banker may do no more than ―lend out what is entrusted to him by the public‖, it remains true that the commercial banks collectively can lend out several times the amount of any addition to their collective cash reserves.

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